A New Perspective on Policy2006 Streich Family Lectureship
on Free Enterprise

I am delighted to be back in Wichita
Falls. I spent some considerable time here in 1994,
when I took leave of my senses and ran for the United
States Senate. The good people of this city were always
nice to me, especially Dottie Murphy, who is here today—thank
you, Dottie. I remember the first time I met your wonderful
mother, God rest her soul. She had on a white blouse,
a jean skirt and bright red cowboy boots, and she looked
a third her age and like the belle of the ball. She
was a true Texas gem, and we all miss her.

I ran that one time for office
and that was it. Veni, Vidi, Defici: I came, I saw,
I lost. It was not my cup of tea; I was no good at it
and was a fish—or, I guess you can say, a fisher—out
of water. I was better suited for the assignment of
ambassador and trade negotiator of the United States.
That, in turn, proved to be excellent preparation for
what I do today as president of the Federal Reserve
Bank of Dallas and as a participant in the Federal Open
Market Committee, the monetary policy setting body of
the Federal Reserve System. Today is, in fact, the anniversary
of my becoming Dallas Fed president last year. So I
thought it might be of interest to share with you what
I have gleaned from these past few years and what I
am now up to as we speak. Before doing so, let me state
at the outset that the views I express today are strictly
my own and that I am not speaking for the Federal Open
Market Committee or others in the Federal Reserve System.

And before getting into my prepared
remarks, I want to acknowledge my traveling companion
today, Wichita Falls’ and Midwestern’s own
James Hoard. James is my right arm at the Fed. He is
a superb counselor and friend and does his best to keep
me out of trouble. James, raise your hand, so that if
I do make any mistakes today, everyone will know who
to blame.

One of my first acts as Dallas Fed president was to
challenge our researchers to think deeply about how
globalization is changing the ways our economy works—in
particular, how we need to alter the rules and practices
of monetary policy to accommodate an increasingly interconnected,
interdependent global economy.

The literature on globalization
is large. The literature on monetary policy is vast.
But literature examining the combination of the two
is surprisingly small.

At year-end last year, if you
had Googled “globalization” and “monetary”
and “policy,” you would have turned up more
than 2 million references. However, a search of scholarly
articles with the same word combination turned up 30,700.
If you had narrowed your quest to the exact word combination
“globalization and monetary policy,” you
would have found a mere 39 citations. Limiting the word
combination to the title of an article, you would have
found only two.

Tom Friedman’s popular book
The World Is Flat: A Brief History of the Twenty-First
Century—a book I’ll bet many of you
have read—doesn’t have a single entry on
“money,” “monetary policy” or
“central banking.” And in Michael Woodford’s
influential book Interest and Prices: Foundations
of a Theory of Monetary Policy—a book you
probably haven’t read but should if you delight
in economics—the word “globalization”
does not appear in the index. Nor do the words “international
trade” or “international finance.”

What gives? Is the process of
globalization disconnected from monetary policy? Is
the business of the central bank totally divorced from
globalization?

I think not. I believe globalization
and monetary policy are intertwined in a complex narrative
that is only beginning to unfold.

There are many convoluted definitions
of globalization. Mine is simple: Globalization means
economic potential is no longer constrained by political
and geographic boundaries. A globalized world is one
where goods, services, capital, money, workers and ideas
migrate to wherever they are most valued and can work
together most efficiently, flexibly and securely.

Where does monetary policy come
into play in this world? Well, consider the task of
the central banker, seeking to conduct monetary policy
to achieve maximum sustainable non-inflationary growth.

Former Federal Reserve Governor
Larry Meyer gave an insider’s view of the process
in his excellent little book A Term at the Fed.
It was one of the first things I read as I prepared
for my new job. In it, you get a good sense of the lexicon
of monetary policy deliberations. The language of Fedspeak
is full of sacrosanct terms, such as “output gap”
and “capacity constraints.” There is the
“natural rate of unemployment,” which morphed
into “the non-accelerating inflation rate of unemployment,”
or “NAIRU.” Central bankers want GDP to
run at no more than its theoretical limit, for growing
too fast for too long might stoke the fires of inflation.
They do not wish to strain the economy’s capacity
to produce.

One key capacity factor is the
labor pool. A shibboleth known as the Phillips curve
posits that unemployment falling beneath a certain level
ignites demand for greater pay, with inflationary consequences
for the entire economy.

Until recently, the econometric
calculations of the various capacity constraints and
gaps of the U.S. economy were based on assumptions of
a world that exists no more. Meyer’s book is a
real eye-opener because it describes in great detail
the learning process of the FOMC members as the U.S.
economy entered a new economic environment in the second
half of the 1990s. At the time, economic growth was
strong and accelerating. The unemployment rate was low,
approaching levels unseen since the 1960s. In these
circumstances, inflation was supposed to rise—if
you believed in the Phillips curve and the prevailing
views of potential output growth, capacity constraints
and the NAIRU. That is what the models used by the Federal
Reserve staff were saying, as was Meyer himself, joined
by nearly all the other Fed governors and presidents
gathered around the FOMC table. Under the circumstances,
they concluded that monetary policy needed to be tightened
to head off the inevitable. They were frustrated by
Chairman Greenspan’s insistence they postpone
the rate hikes.

We now recognize with 20/20 hindsight
that Greenspan was the first to grasp changes in the
traditional relationships among economic variables.
The former chairman understood the data and the Fed
staff’s modeling techniques, but he was also constantly
talking—and listening—to business leaders.
And they were telling him they were simply doing their
job of seeking any and all means of earning a return
for shareholders. At the time, they were being enabled
by new technologies that enhanced productivity. The
Information Age had begun rewriting their operations
manuals. Earnings were being leveraged by technological
advances. Productivity was surging. Inflation wasn’t
rising. Indeed, it just kept on falling.

If the advice of Meyer and the
others had prevailed, the Fed would have caused the
economy to seriously underperform. According to some
back-of-the-envelope calculations by economists I respect,
real GDP would have been lower by several hundred billion
dollars. Employment gains would have been reduced by
perhaps a million jobs. The costs of not being right
on the critical calibrations of monetary policy would
have been huge.

We live in a globalizing era.
Just consider what the fall of the Soviet Union, the
implementation of Deng Xiaoping’s “capitalist
road” in China and India’s embrace of market
reforms mean to business operators. Consider labor alone.
In the early ’90s, the former Soviet Union released
millions of hungry workers into the system. China joined
the World Trade Organization at the turn of the century
and injected 750 million workers into play. And now
India, with over 100 million English-speaking workers
among its 1 billion people, has joined the game. Just
two weeks ago, a CEO told me his company posted ads
for people to apply for 9,000 jobs in a new facility
in India. Do you know how many applications they received?—1,400,000.

How does this affect the American
manager—paid to enhance returns to shareholders
by growing revenues at the lowest possible costs? Because
labor accounts for, on average, about two-thirds of
the cost of producing most goods and services, the managers
will go where labor is plentiful and cheapest. They
will have a widget made in China or Vietnam, or a software
program written in Russia or Estonia, or a center for
processing calls or managing a back office set up in
India.

Let me tell you of one eye-opening
experience. About two years ago, I was in London on
business for Kissinger McLarty. I received a call from
the head of Japan’s equivalent of the Business
Roundtable, the Keidanren, asking me to “pop over
tomorrow to give a luncheon and dinner speech.”
They made an offer I couldn’t refuse, and I said
I would be glad to do it if they could arrange the flights.
They booked me on Virgin Air and arranged for a car
to take me to Heathrow. At the appointed time, the car
didn’t show up. So I called the number I had been
given. The call was answered by a woman with a frightfully
British accent. When I asked, “Could you kindly
tell me where my car is, ma’am?” she deftly
shifted to a Southwestern American accent and said,
“Now don’t you worry. It is five minutes
away. Ah apologize for the delay. Have a nice flight.”

I said, “Well, hold on a
minute. You answered this call in a British accent but
once I spoke, you shifted to a Texas accent. Who are
you? Where are you?”

“Well,” she answered,
“I am a call center operator in Bangalore.”

“Have you ever been to the
United States?” I asked.

“Oh, no, sir. But I can
tell that you are from Arkansas, Texas or New Mexico.”

“And how do you learn to
speak like me?”

“Well, sir, for people like
you, we watch a telly show called Walker, Texas
Ranger.”

“And what if I were from
Boston?”

“Ah, for those people we
watch Cheers.”

It may seem like a small matter
that a Japanese firm employed a worker in India to track
a car by GPS in London and mimic a voice from Texas.
But globalization impacts the conduct of business so
much more profoundly, and therefore it impacts the expansion
of our productive capacity and the pricing mechanism
of labor and other inputs.

The destruction of communism and
the creation of vast new sources of inputs and production
have upset all the calculations and equations of the
very best economics minds, including those of the Federal
Reserve staff. Many of the old models simply do not
apply in the new real world. This is why I think so
many economists have been so baffled by the length of
the current business cycle as well as the non-inflationary
prosperity we have enjoyed for almost two decades.

You could sense something was
wrong with the econometric equations if you listened
to the troops on the ground, fighting in the trenches
of the marketplace. This is what I did at the U.S. Trade
Representative’s office in negotiating market-opening
trade rounds with China, Vietnam, Mexico, Brazil and
others. It is what my colleagues and I at Kissinger
McLarty did while advising dozens of U.S. companies
seeking entry into China and the former Soviet satellites
and India and Latin America. It is what my colleagues
and I on the FOMC do by making dozens upon dozens of
calls to CEOs, COOs and CFOs of businesses, large and
small, every month to prepare for FOMC meetings.

We are simply observing managers
at work expanding the capacity of our economy, expanding
the gap between what their previously limited resources
would allow them to produce and what their newly expanded
globalized, technologically enhanced reach now allows
them to produce.

From this, I personally conclude
that we need to redraw the Phillips curve and rejig
the equations that inform our understanding of the maximum
sustainable levels of U.S. production and growth. How
can economists quantify what the U.S. can produce with
existing labor and capital when we don’t know
the full extent of the global labor pool we can access?
Or the totality of the financial and intellectual capital
that can be drawn on to produce what we produce?

So what does the limited research
on resource utilization and output gaps tell us? There
are a few key, but preliminary findings from work done
at the Bank for International Settlements—what
many consider “the central bankers’ bank”—and
some as yet unpublished work done by several of our
Dallas Fed economists. Here are a few key points:

The relationship between measures of domestic economic
slack, such as industrial capacity utilization, and
domestic inflation seems to have declined across a
broad range of advanced countries in recent years.

At the same time, proxies for global slack—such
as unemployment rates and output gaps in a wide array
of countries—seem to be of growing importance.

And for some countries, including—and to
my mind especially—the United States, the proxies
for global slack have become more important predictors
of changes in inflation than measures of domestic
slack.

At first, I was encouraged on
hearing these results. But then I was reminded about
how difficult it is to accurately measure slack in the
U.S. economy in real time. Data revisions in these measurements
are often quite large. Imagine how much more difficult
it is to measure in real time the degree of slack or
capacity utilization that exists across the landscape
of, say, 10 other economies across the globe!

The realization of the importance
of global economic conditions for making monetary policy
decisions is becoming more widespread. Several of my
colleagues on the FOMC have offered encouragement to
the globalization research efforts under way at the
Dallas Fed. In February, I had the opportunity to give
a speech in London and to meet with Mervyn King, the
governor of the Bank of England. Foreign trade has long
been important to the prosperity of the U.K. London’s
financial markets play a pivotal role in global capitalism.
So policymakers in the U.K. are used to thinking globally
when it comes to making policy. After a robust conversation
with Governor King, it became abundantly clear that
we share many views on the importance of globalization
for monetary policy. In recent years, globalization
has manifested itself in the U.K. in the form of inflows
of foreign workers that have alleviated labor market
pressures and allowed the Bank of England to keep interest
rates at levels lower than might otherwise be the case.
Globalization has also shown up in greater external
competitive pressures on U.K. firms, and thereby affected
the dynamics of inflation in the U.K. Bank of England
staff have an ongoing research project to understand
the causes of what they refer to as the Great Stability
and we refer to as the Great Moderation—the decline
in inflation and output volatility that we have seen
in many countries in recent years. Globalization is
almost surely part of the explanation.

Recognition of the importance
of global economic forces for the making of economic
policy is not limited to monetary policy. Just last
week, the Antitrust Division of the U.S. Justice Department
decided not to impose any restrictions on the merger
of Whirlpool and Maytag, two manufacturers of washing
machines and clothes dryers that together control roughly
70 percent of the U.S. market. In the old days, this
would be unthinkable. Today, the reason for not being
too concerned with the potential for the combined companies
to exert monopoly power is fairly straightforward. There
are many manufacturers of laundry machines desirous
of entering the U.S. market. In other words, there are
abundant potential capacity and resources available
outside the United States that can, and will likely,
offer competition to Whirlpool/Maytag, thereby reducing
their power to boost prices.

I freely admit to you that I do
not have the answers when it comes to globalization
and monetary policy. I do believe that I am asking the
right questions, as are my counterparts in many parts
of the world. We at the Dallas Fed will continue to
explore this topic, and we will share our findings with
the public. We will have to, now that I have made them
public right here at Midwestern! In fact, we are putting
the finishing touches on a new study about how globalization
shapes public policies—from innovation to the
regulatory environment and quite a bit in between. It
is fascinating stuff, and I look forward to sending
it to you through James in about a week or so.

About the Author

Richard W. Fisher is president and CEO of the Federal Reserve Bank of Dallas.

The views expressed by the author do not necessarily reflect official positions of the Federal Reserve System.